Hyperinflation is that transition period when a paper money is clearly failing as a store of value but has not yet died as a medium of exchange. This blog is to look at this and any other interesting economic issues. Vincent Cate

Monday, October 20, 2014

When volatility returns, for a number of reasons, including those I have already mentioned, it may well rise quite rapidly.

But if we look back at previous market sell-offs, when market-making capacity was larger, we see that they were often quite violent too.

There are a few other reasons to suspect that the sell-off, particularly
in fixed income, could be relatively violent when it comes.

But there are probably a sizeable number of investors who are presuming
they can exit their positions ahead of any sell-off. History tells us
that this is generally not a successful strategy. The exits tend to get
jammed unexpectedly and rapidly.

Another reason to suspect that the sell-off might be violent is the
starting point, namely zero nominal interest rates. That is a point we
haven’t started from before (with the possible exception of Japan).

So
there is a fair chance that volatility will feed on itself. One should
always be careful of looking for too much rationality in trying to
understand market dynamics. Given the lack of rational arguments for the
current state of affairs, trying to rationally explain how it will
unwind is also going to be difficult.

So in conclusion, there are a number of anomalies present in financial
markets in terms of pricing and volatility. There are also some
misplaced perceptions amongst market participants about the degree of
liquidity present in some market segments. That strikes me as a dangerous combination and unlikely to be resolved smoothly.

I also think a bond panic will feed on itself. I think the end result will be that the central bank makes lots of new money and buys up lots of bonds, and the value of the currency goes down.

Saturday, October 4, 2014

Noah Smith wrote Japan's Debt Trap where he concludes that Japan will monetize their debt. On this point I believe he is correct, Japan will monetize their debt. However, he says a few other things I do not agree with.

Noah:

But if inflation strikes, it could rise high enough to hurt growth, and
therefore tax revenue, severely. That would mean game over -- Japan’s
government would be forced to default (or to hyperinflate, which amounts
to a messier version of the same thing).

Defaulting would not really help because much of the debt is owed to their retired voters. The government would still end up having to take care of these people, so it would not save that much. After defaulting the government would still be spending nearly twice what they get in taxes but now the central bank would be the only bond buyer for sure. With the central bank clearly monetizing their deficit, they would get hyperinflation even after defaulting. Default in Japan would not avoid hyperinflation. Yes, hyperinflation amounts to a messier version of default.

Noah:

But I’m not worried. In the end, a sovereign default is just an
accounting exercise -- marking down the assets of some Japanese people
and marking up the assets of others.

He should be worried. Hyperinflation destroys an economy. It is not just an accounting exercise. I suspect he need to read my CMMT article.

Noah:

The fact is, no one really knows what causes high-inflation episodes to begin.